by Calculated Risk on 8/28/2005 09:22:00 AM

The LA Times has two related articles this morning on borrowing and bankruptcy. From "Equity Is Altering Spending Habits and View of Debt":

People are cashing out so quickly that the term "homeowner" may soon be inaccurate. Fifty years ago, Americans owned, on average, three-quarters of their house and the lender owned the rest. These days, it's approaching an even split.

This spend-now-rather-than-save-for-later phenomenon has produced undeniable benefits. Experts attribute much of the nation's economic growth to cash-out refinancings, home equity loans and other methods of tapping rising home values.

This is behavior is being encouraged by industry "experts":

"If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years," said David Lereah, chief economist of the National Association of Realtors and author of "Are You Missing the Real Estate Boom?" "It's as if you had 500,000 dollar bills stuffed in your mattress."

He called it "very unsophisticated."

Anthony Hsieh, chief executive of LendingTree Loans, an Internet-based mortgage company, used a more disparaging term. "If you own your own home free and clear, people will often refer to you as a fool. All that money sitting there, doing nothing."

The financial services industry is doing all it can to avoid letting consumers be foolish. Ditech.com touts home loans as a way to pay off credit cards, and Morgan Stanley says they're a good way to fund education expenses. Wells Fargo suggests taking a chunk out of your house to finance "a dream wedding."

The entire article is fascinating, but this anecdote shows poor financial planning:

He bought his condo in expensive Marin County, north of San Francisco, for $510,000 in April 2004. The bank offered to finance the whole thing, but he decided to be a little conservative and put 5% down.

By January, the condo was worth $555,000, and Levy refinanced. He took out $25,000 in cash, less than the bank offered to give him. The money paid off what he describes as "really ugly" credit card debt.

The interest rate on the credit card had been more than double the rate on his mortgage, so he saved about $600 a month. Furthermore, his mortgage interest is tax-deductible; his credit card interest was not.

"It used to be that all debt was created equal and all debt was evil," Levy said. "But the tax breaks alone make a pretty compelling case to use home equity to finance just about everything."

Although money is fungible, paying for short term assets with long term debt is poor financial planning. Imagine going to a fast food restaurant and buying a hamburger on your credit card. Then you borrow money against your house to pay off your credit card debt. Now you are financing lunch for 30 years!

The other article in the LA Times, "A fresh calamity?", fits nicely with the first.

Under the new bankruptcy regulations, homeowners will no longer necessarily be able to hand the keys to the bank and move on. Lenders will, in many cases, have the option of coming after them for virtually everything else they've got -- income, money in bank accounts and other assets.

Homeowners who have refinanced may have unwittingly put themselves at the greatest risk. State regulations will still offer financial protections for buyers who have their original mortgages.

"There is no doubt this law will make it harder for some people to walk away," said Gary Painter, a professor at the USC School of Policy, Planning and Development. "It definitely could hurt homeowners."

For homeowners that are heavily in debt, and have refinanced or used a HELOC (Home Equity Line of Credit), this might be their future.

I wonder who is going to look "foolish" and "unsophisticated" in the coming years.